Archive - Mar 7, 2013

Minutes ago the January Consumer Credit report was released. It was expected to post an increase of $14.7 billion. Instead it rose by $16.2 billion. On the surface this would be great: consumers are spending more, levering up confident in the future, etc, etc. Alas, as always in the New Normal, the story was below the surface. Specifically, of the $16.2 billion rise, a tiny $106 million was due to revolving, or discretionary spending credit card, debt. The balance, or 99% of the total, was non-revolving debt, best known as student loans, and less known as GM NINJA car loans. And here is the scary math: in the past 12 months, of the $153 billion in total consumer credit increase, just $6.4 billion was in revolving credit. The balance: student and car loans.

When it comes to assets, there are two kinds: hard, tangible assets such as real estate, equipment and durable goods, and then there are financial assets, or "things" that only have an actual worth in the context of a capital market and a smoothly functioning financial system allowing for value-for-value exchanges and mark-to-market: among these are corporate equities, mutual and pension fund shares and reserves, credit instruments and equity in non-corporate businesses. We bring this up because today, as it does every quarter, the Fed released its Z.1, Flow of Funds report, which shows total US household assets and liabilities. Not surprisingly, with the ongoing surge in the stock market courtesy of the Fed's open-ended QE ticking time bomb, and the second housing bubble courtesy of the banking subsidy known as foreclosure stuffing, in the quarter ended December 31, 2012, at least according to the Fed, the US household's total net worth rose by another $1.2 trillion, taking it to $66.1 trillion. However, one thing was particularly notable in this latest update, and as implied by the above paragraphs, is that as of Q4, 2012, total US household financial assets hit an all time high of $54.4 trillion, well over the previous peak of $52.8 trillion in Q3 2007, and nearly $1 trillion higher compared to the past quarter. In other words, as of Q4 2012, the US household's net worth has never been more reliant on the stock market, which by implication means: Ben Bernanke and his centrally printing colleagues around the world.

Earlier we noted the relative un-cheapness of the US equity market and its elevated expectations that seem just a little excessively hope-driven relative to any historical precedent. However, the decision still remains, do you buy moar here at the highs (as it's different this time) or cover/protect? The following chart, from Morgan Stanley, offers some insight into just how broadly 'expensive' this market is. Each time more than 45% of stocks have reached these valuation levels in the past 13 years, the market has decided enough is enough and shaken loose. But as we keep being told, it is different this time.

Despite reassurances from Draghi this morning, the truth of the matter is that cross-border capital flows - which reflect the degree of integration in the global financial system - have plunged in recent years. As of the end of 2012, cross-border capital flows - including lending, foreign direct investment, and purchases of equities and bonds - remain more than 60% below their peak. In the decade up to 2007, Europe accounted for half of the growth in global capital flows, reflecting the increasing integration of European financial markets. But today the continent’s financial integration has gone into reverse. Clearly, cross-border lending, which dominated capital flows in the years leading up to the crisis, has proven to be short term and can dry up quickly.

What bothers me is that those who are now pushing the story that deficits aren't a problem, are the same ones who will be crying, "We never could have seen that happening", when the SHTF again.

Though much has been written about the popping of the housing bubble in the U.S. and Ireland, remarkably little has been written about the many housing bubbles that remain unpopped. As a rule, speculative bubbles pop and revert to their pre-bubble levels, so we can anticipate the eventual popping of all remaining housing bubbles. Given the dearth of investment options open to households in China seeking to invest their prodigious savings, it is unsurprising that China's housing bubble continues expanding. Every proponent of housing during bubbles confidently proclaims that "this time it's different," and a decade later the dazed survivors shift through the financial rubble, wondering what went wrong with "guaranteed" fundamentals, trends, valuations, collateral and wealth.

Warning from the German Bankers Association: central-bank save-the-euro policies cause bubbles, capital misallocation, currency wars, and another financial crisis.

In the following presentation, given by Howard Marks - the world's largest distressed debt investor - he warns of the perils of "investing in uncertain times." As Reuters notes, he fears the "unsound practices" from before the financial crisis are creeping back into credit markets, with private equity firms bidding increasingly high prices for companies. Marks points out the ease with which lowly rated companies were issuing debt this year, how companies were paying out record dividends to their shareholders and the increasingly high debt-to-equity multiples private equity firms were paying for companies amid a resurgence in deals. "We have a world in which nobody is thinking bullish. Everybody's worried and yet people are acting bullish," and predicts a looming "shake-out" in the hedge fund industry as he asks rhetorically, "today there are 8,000 hedge funds. Are there really 40,000 exceptional people (working for hedge funds)?" In conclusion, Oaktree Capital's founder warns that investors, in their search for returns, were becoming overly confident while the economic background was still gloomy.

They got a basketball jones...

How Far Will the Government Go to Defend the Too Big to Fail Banks?

Tax refunds, which can be an important source of cash flow for consumers early in the year, have totaled $20bn less year-to-date than refunds in 2012. Goldman Sachs notes that this is the equivalent of nearly 1% of disposable income over that period, and some consumer-oriented businesses have attributed lackluster sales in late January and early February to lower refund payments. Balancing the possibility of a small amount of additional catch-up with the possibility that some of the decline versus 2012 is fundamentally driven by the effects of tax law changes or other factors, the upshot is that Goldman believes the cumulative gap of around $20bn looks likely to persist. Since the current rate of change in tax refunds looks similar to last year's, this should not weigh further on consumer cash flow. However, it also implies that we should not expect the consumer to receive much of a tailwind from delayed tax refunds in March or April. It does make one wonder a little if this marginal cash-flow is the reason for the extremely unusual cyclical strength and weakness we have seen in macro data for the last few years.

It took six months of humiliatingly empty rhetoric and bluster, before Europe's press corps, or rather just the FT's Michael Steen, finally asked perhaps the one most important question regarding the OMT, which does not stand for On Merkel's Tab, but rather "Outright Monetary Transactions" (full Draghi definition here) and is the magic "open-ended" bond-buying bullet and SMP replacement that has stabilized Europe: namely "what is it?" That it took so long for reporters, and by implication, the markets to actually point out that the emperor is indeed naked and inquire into the legal working of the ECB's deus ex machina is a testament to just what lengths the broader public has been zombified into believing that "the less you know, the better" historically, one of the KGB's better known slogans.

A 'successful' Spanish auction and Draghi's reassuring anti-currency war chatter had little to no effect on Europe's equity markets but FX and bond markets moved quite significantly. A mix of small gains (CAC, DAX) and small losses (Italy, Switzerland) in stocks but Italian and Spanish bond spreads dropped 10-15bps further (down 30bps on the week) - back well below the pre-Italian election levels and Portugal goes from strength to strength on the small ratings upgrade last night (-50bps on the week). EURUSD was the story (and EURJPY) as a lack of concern over Euro potential strength by Draghi drove it to run stops above recent highs and end the day at 1.3100 (up around 130 pips on the day). EURJPY is now back to pre-Italian election levels.

Each and every day, we are bombarded by a never-ending series of asset-gatherers whose sole aim in life is to convince investors to put more money to work. Whether it is because 'we are climbing a wall of worry', whether 'long-term' equity investors always do well, whether the 'cash on the sidelines' is coming out (note - remember there is a seller for every buyer and a buyer for every seller); the most frequently proposed reason for buying stocks is 'because they are cheap'. No matter where they are trading - high or low - they are cheap. Well, in an attempt to suggest otherwise - or at least provide fact rather than accepted wisdom, the following two charts from Morgan Stanley's Adam Parker provide the reality that, in fact, stocks are not cheap - and given where rates are, they are in fact expensive. Empirical fact not fiction.